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1997 (4) TMI 115
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....r the printed (Audited) Profit and Loss account of the company for the year ended on 31st December, 1986 (relevant to the year under appeal for assessment year 1987-88) is Rs. 1,04,10,150. The company has adopted a system of accounting called the "SUM OF DIGITS METHOD" (for short referred to as the 'SOD' method) which is also known as the 'Indexing Method' for recognition of its income from the business of hire-purchase and leasing. According to the SOD method, the company recognises its income on a time proportion basis taking into consideration the amount outstanding from time to time and the rate applicable. The loading of the entire income is apportioned over the period of the contract in proportion to the reducing balances that will be outstanding from time to time after taking into consideration the repayment schedule in the form of monthly equated instalments. According to the 'SOD' method, the income is thus overstated in the earlier years and in the latter years covering the period of Hire Purchase Agreement/lease Agreements, it is understated. 2.2 However, the company, while filing its income-tax return for assessment year 1987-88, as in the earlier years, has claimed ....
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....anies, to the other public institutions that the affairs of the Company is true and fair manner and, hence, rejection of books is not warranted. (iii) The assessee has paid an amount of Rs. 60 lakhs as dividend to the shareholders and created reserve to the tune of Rs. 44 lakhs. Thus, an amount of Rs. 1,04,00,000 is transferred to either capital account or paid as dividend. If the income has not accrued to the assessee to the tune of Rs. 52,83,931 so much of the amount out of the borrowed funds have been paid to the shareholders as dividend. Alternatively, the interest the claim on this amount should not be allowed. However, I am of the view that the assessee-company did receive this much of profit so that they are in a position to pay dividend to the shareholders. (iv) On the above points and also considering that the other companies in this group are claiming various allowances on the basis of book results even though they are following similar method of accounting, the assessee's contention is not accepted and rejected." 4. The company preferred an appeal against the said assessment order before the Commissioner of Income-tax (Appeals)-IV, Andhra Pradesh, Hyderabad [her....
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....on as under: "The answer is, according to me, that the terms, conditions of hire purchase agreement should prevail over whatever method the appellant had adopted to account for finance charges. The income in the scheme of a contract accrues on the basis of the terms of agreement or the contract and not on a tortium quid. When the appellant is entitled only to collect whatever is stated in Schedule II of the hire purchase agreement, it cannot be said that the appellant collected more by virtue of book entries made by it following indexing method. Where the parties are governed by the terms of the contract and the contractual obligations, it would be far fetched to state that the right to receive for duties performed in accordance with the terms of the contract was, outside the purview of the contract - Such a proposition would be paradoxical. Accordingly, it would stand to reason that Schedule II of the hire purchase agreement dealing with finance charges would prevail over any other method adopted by the appellant to account for finance charges." He, therefore, held that the finance charges arrived at as per the index system does not definitely represent the amount due to the....
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....ed in allowing the assessee's claim of differential income as loss. 2. The CIT(Appeals) should have considered that the assessee's books of account are maintained on the method of accounting followed regularly and recognised internationally and as per provisions of section 145, the book results are not rejected and profits from business are computed on the basis of books of account maintained. 3. The CIT(Appeals) should have considered that the assessee paid dividends to the tune of Rs. 60 lakhs on the basis of the income which are shown in the P & L Account. 4. The CIT(Appeals) should have considered that the assessee has maintained the books of account as per the provisions of company law and the same is submitted to the shareholders also. 5. Any other grounds of appeal that may be urged at the time of hearing." 6.1 The learned Senior Departmental Representative (hereinafter referred to as "Sr. D.R.") at the outset invited our attention towards the decision in the case of Nagarjuna Finance (P.) Ltd. in [IT Appeal Nos. 2777 and 2967 (Hyd.) of 1988 dated' 13-3-1995] in which the Tribunal, on identical facts, decided the similar issue in favour of the Revenue. The Tri....
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....t the end of the financial year give a true and fair view. In the present case, the profit and loss account prepared in accordance with the books of account maintained by the assessee has been approved by the Board of Directors confirming, inter alia, the fact that the profit and loss gives a true and fair view of the profit for the relevant financial year. The company has approved the said audited accounts in its General Meeting. The auditors have also certified that the profit and loss account give a true and fair view of the profits of the company for the relevant financial year. The learned D.R. invited our attention towards auditors' report to corroborate the aforesaid contention. He submitted that the audited profit and loss account disclose a net profit of Rs. 104. 10 lakhs out of which dividends of Rs. 60 lakhs were declared for payment to shareholders and Rs. 44 lakhs were transferred to reserves. Section 205 of Companies Act provides that dividends can be paid only out of profits. The amount of Rs. 60 lakhs has been paid by way of dividend to the share holders in conformity with the requirement of section 205 of the Companies Act. The assessee has, therefore, treated the ....
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....rchase system. For this purpose, he explained the examples given in para 7 of the order passed by the Tribunal in the case of Nagarjuna Finance (P.) Ltd. He submitted that according to the SOD/indexing method followed by the assessee the interest income is recognised in the books of account in such a manner that the entire amount of interest income covering the period of hire purchase agreement/lease agreement will be apportioned over the period of the contract in proportion to the reducing balances that will be outstanding from time to time. It ensures determination of income at a uniform rate of interest implicit in the hire purchase and lease agreement. Such a method of apportionment of the interest income over the period of the hire purchase agreement/lease agreement represents real and true income of the relevant financial year. If the method adopted by the assessee for the purposes of computing its taxable income is accepted, it will lead to absurd results as has been aptly discussed by the Tribunal in the case of Nagarjuna Finance (P.) Ltd. in para 8 of their order. The examples given in para 8 of the said order indicate that interest income, according to the assessee in the....
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....; in the second installment it will be 19/210 of the total loading and so on. (c) Equal installment or straight line method : Under this method, income from finance charges is treated as accruing uniformly over the life of each agreement. This method automatically creates a provision against bad debts and possible increase in the cost of providing finance, since in the initial years the credit to the profit and loss account will be less than under methods (a) and (b) given above. But this method ignores to a large extent initial expenses interest paid, etc. (d) Direct or arbitrary percentage method : A percentage of the outstanding balance is carried forward as deferred income. For best results, the percentage should be determined annually after considering a good sample of the agreement. 6.6 The learned Sr. D.R. submitted that income by way of financial charges derived by the assessee in relation to a transaction of hire purchase is nothing but interest income. Interest is compensation for use of money. He invited our attention towards the definition of the expression 'interest' as given in various dictionaries: "FROM STROUD'S JUDICIAL DICTIONARY (VOL. 3, FOURTH EDI....
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....e, there are 36 installments. The quantum of each installment is fixed as under : 1,42,000 --------------- = Rs. 3,944.44 36 Thus, the hirer pays Rs. 3,944.44 in the first month and each of the succeeding 35 months. Out of Rs. 3,944.44, there is a principal repayment component and interest component. To calculate the actuarial interest the method takes into account all the factors, viz. (a) Principal amount financed (b) Total interest amount (c) Total period (d) Total number of instalments (e) The fact of reducing principal amount on each successive instalment. (f) To give the result in such a way that the rate of interest is approximately constant throughout to give consistent results. The mechanism is as under: The total interest (Rs. 42,000) is Multiplied by the specific number of instalments which is divided by a particular factor. The factor is calculated by using the formula : N(N+ 1) Note: 'N' is the total number of instalments. ------------- 2 Thus the factor (index) applicable to the examples would be as under : 36 (36 + 1) ------------------- = 666 2 The formula for working out the interest component of a g....
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....------ The interest income is progressively reducing with the reduction in the outstanding principal amount. The overall interest rate is constant. (This interest rate is the ordinary rate). II Accrual Method (Note : The name given to this method is accrual method whereas in reality this is not based on accruals). Interest rates in accrual method when calculated with reference to the outstanding principal amounts: -------------------------------------------------------------------------------- Year Outstanding Total of Interest in Principal Interest amt at the installments year begin accrual component rate -------------------------------------------------------------------------------- I 1,00,000 47,334 14,000 33,334 14 per cent II 66,666 47,333 14,000 33,330 21 per cent III 33,333 47,333 14,000 33,330 42 per cent ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- Thus, in the accrual method sought by the assessee, the interest rate works out to 14 per cent in first year and 42 per cent in 3rd year and, therefore, accrual method....
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....cordance with such a well-recognised method of accounting. The assessee cannot adopt another method by computing its taxable income on the basis of a different method of accounting which gives distorted figures of income and results in deferment of tax liability. The SOD method is more appropriate, logical, scientific and is in accordance with the prudential norms mentioned in International Accounting Standards as well as the accounting standards now issued by the Institute of Chartered Accountants of India. The method chosen by the assessee for showing its taxable income is illogical, incorrect and has been chosen purely for deferment of the tax liability. There is a perpetual postponement of the tax liability, if the method suggested by the assessee for computing its taxable income is accepted. 6.7 The learned Sr. D.R. submitted that income shown by the assessee in its books of account, therefore, clearly comes within the ambit of charging section 5 and it cannot be said that the assessee has accounted for certain hypothetical or extra income, which in fact did not accrue to the assessee in the relevant previous year. 6.8 The learned D.R. further submitted that in the prese....
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.... to the Special Bench necessarily postulates that income in the books of account maintained by the assessee on the basis of SOD method is more than income to be computed on accrual basis. If the assessee by following the SOD system has accounted for certain income which did not accrue to the assessee, it cannot be taxed on that income because such differential income has not accrued to the assessee in accordance with the charging provisions contained in the Income-tax Act. 7.1 The learned counsel submitted that even if the question whether the income as returned by the respondent is the only income which has accrued is to be regarded as being in issue, the observations made by the CIT(Appeals) at pages 2 and 3 of his order, wherein he has mentioned that the DC(Asstt.) in his remand report dated 3-12-1990 is not opposed to adopting income from leasing on accrual basis, make it clear that the issue will arise only in respect of hire purchase amounts and not lease rentals. The Assessing Officer in his aforesaid remand report has accepted that only income which has accrued in respect of lease rental is that which has been returned by the assessee in its return of income. He submitte....
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.... of accounting regularly employed by the assessee and as the method of accounting followed is not disputed and the proviso to section 145 is not applicable, the assessee's contention cannot be accepted. The ITO has also held that the assessee has shown to the investing public, to the Registrar of Companies and to other public financial institutions that the affairs of the company are reflected in a true and fair manner and, hence, rejection of books of account is not warranted. The Assessing Officer has further observed that the assessee has paid an amount by way of dividends which is in excess of the amount which it could have paid on the basis of the taxable income declared by it. Lastly, the Assessing Officer has stated that whereas the other companies in the group are claiming various allowances on the basis of book results even though they have for tax purposes taken a lesser income into consideration. The learned counsel submitted that the Assessing Officer has brushed aside the assessee's contention that unless income has accrued to an assessee within the meaning of charging sections 4 & 5 of the Act, namely, it has a right to receive the same, the assessee cannot be assesse....
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....ted our attention toward the judgment of Hon'ble Supreme Court in the case of State Bank of Travancore v. CIT [1986] 158 ITR 102/24 Taxman 337. Our particular attention was drawn towards the view expressed by Hon'ble Tulzapurkar, J. (dissenting and minority view) at pages 114 and 116 : "The material provisions in regard to the computation of income of an assessee under the head 'Profits and gains of business' are to be found in sections 28(i), 29 and 14(1) but these have to be read subject to section 5 of the Act. Though these provisions provide for charging the income by way of profits and gains of business and prescribe the manner of computation, the question as to what point of time its chargeability arises is answered by section 5 of the Act which states that the total income of a resident assessee from whatever source derived becomes chargeable either when it is received by him or when it accrues or arises to him during the previous year, In other words, taxability is attracted even when income has accrued and it is clear that the receipt of income is not the sole test of taxability under the Act; but, whether on receipt of basis or on accrual basis, it is the real income a....
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....of the Act deals with income from other sources and section 57 deals with deductions in the computation of income from other sources. Section 145 deals with the method of accounting. Sub-section (1) of the said section provides that income chargeable under the heads 'Profits and gains of business or profession' or 'Income from other sources' shall be computed in accordance with the method of accounting regularly employed by the assessee." At page 144, the Hon'ble Court has further observed as under : "For the content of the taxable income, one has to refer to the substantive provisions of the Act, mainly section 5 of the Act read with other relevant sections." 7.7 The learned counsel thereafter invited our attention towards the Commentary (Law and Practice of Income-tax) by Kange and Palkiwala at page 1166 (Eighth edition), Vol. I. It has been mentioned in the said commentary that the assessee's regular method of accounting determines the mode of computing the taxable income but it does not determine or even affect the range of taxable income or the ambit of taxation. The provisions for computation of income contained in section 145 cannot derogate from the provisions of c....
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....ter explained the basic facts relating to the two types of agreements, namely. Hire Purchase Agreement and Lease Agreement. 8. He submitted that the income in respect of hire purchase agreement has been shown in the books of account according to the SOD/index method while for the purposes of income-tax return, it has been shown as per equated method, namely, as per the rate of 14 per cent per annum on interest specified in the said hire purchase agreement read along with application given by the client for the said hire purchase agreement. The income as per these two methods, one, namely, index method adopted for maintaining books of account and other, namely, equated method adopted for filing the income-tax return was as under as per the exact detail submitted at page 88 in relation to the specimen hire purchase agreement submitted at page 35 of the compilation. The learned counsel submitted that in the hypothetical example given by the learned DR the income by way of finance charge in relation to hire purchase agreement according to the aforesaid two methods can be briefly illustrated as under : Hire Purchase : Amount Financed is Rs. 100 Period of Agreement (in years)....
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....counting by Shukla and Grewal relied upon by the learned D.R., inter alia, clearly shows that the equal instalment or straightline method is also one of the recognised method which clearly provides that income from finance charges can be treated as accruing uniformly over the life of each agreement. He submitted that income from hire purchase business has been shown on accrual basis as per the terms of contract for income-tax purposes and the extra income shown on the basis of index method/ SOD method in the books of account cannot be regarded as income accrued to the assessee in the previous year. It may be a good accounting policy but it cannot be regarded as income chargeable to tax within the ambit of section 5 of the Income-tax Act, 1961. 8.2 The learned counsel also submitted that the income from hire purchase agreement shown @ 14 per cent p.a. for income-tax purposes on the basis of rate of interest specified in the agreement is in accordance with the accepted principles and accepted commercial practice as has been approved by the decision by the Bombay High Court in the case of CIT v. Tata Sons Ltd.[1939] 7 ITR 195 at page 198. 9. The learned counsel then explained th....
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....vices etc. by itself is of no avail." The learned counsel explained as to how the income has been worked out as per the SOD method for the purposes of recognition of income in the books of accounts in relation to income from lease rent. The income shown in respect of the specimen lease deed submitted in the compilation was explained by way of the following note submitted at page 39 of the compilation : LEASE : Equipment cost is Rs. 4,07,800.00 Period of Contract 8 years 96 months (From Aug. 1984 to July 1992) Monthly Lease Rental is Rs. 7,816.20 Gross Lease Rental is Rs. 7,50,355.20 1. In the hands of Lessor Company : a. Depreciation will be available. b. On sum of Digits Method Rs. 7,50,355.20 Lease Rental will be credited over Eight years - as follows : Year 1 2 3 Finance charges 1,75,018.42 1,51,811.55 28,604.69 4 5 6 7 8 1,05,397.83 82,190.97 58,984.11 35,777.25 12,570.38 Total : Rs. 7,50,355.20 c. On Accrual Method Rs. 93,794.40 per annum as lease rental returned (7816.20 X 12 months) 2. In the hands of Lessee. a. No Depreciation b. Lease Rental of Rs. 93,794.40 per annum will be allowed as deduction." The learned cou....
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....0] 39 ITR 8 at page 14. The relevant extract from the said judgment are reproduced hereunder : "Counsel for the appellant relied on the entry in the books of account of the company where the words used are "amount accrued Rs. 5,11,875", but this entry must be read as a whole and it shows that the amount which the managing agents were entitled to receive was Rs. 4,11,875. No doubt in this case the amounts of commission were credited every six months which only means that as an interim arrangement the accounts of all sales were made up at the end of six months also. But this would not affect the construction of the clause containing the terms for payment of commission nor the reduction made therein as a result of the modified arrangement. The amount which would arise or accrue and the managing agent would have the right to receive cannot be affected by the manner in which the entry was made." 12. The learned counsel further submitted that the mere fact that in the books of account certain income is reflected it does not necessarily follow that the same is assessable. For this purpose, he placed reliance on judgments in the case of Shoorji Vallabhdas & Co. , CIT v. Kerala State ....
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....nies Act is different than the meaning of accrual of income within the meaning of section 5 of the Income-tax Act. The concept of 'true and fair" is applicable for the purposes of Companies Act. The method of recognition of income according to SOD/indexing method may be permissible for the purposes of compliance with the provisions of Companies Act. It may be good accounting for the purposes of reporting to the investing public or the shareholders but it may not give a correct picture about income liable to tax under the provisions of Income-tax Act. He submitted that even in the guidance note at page 2) of the paper book submitted by the department, it has been clearly indicated in para 27 that the specific treatments for determining taxable income would have to be in accordance with the provisions of the Taxation Laws. Such treatments may differ from the recommendations contained in the guidance note. The learned counsel submitted that there may be various circumstances under which the income recorded in the books of account does not tally with the income chargeable to tax. For this purpose, he invited our attention towards the judgment of Hon'ble Supreme Court in the case of Bri....
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....hich may be treated as a revenue expenditure/interest income in the books but for tax purposes is treated as part of the cost of the securities (Vijaya Bank Ltd. v. Addl. CIT [1991] 187 ITR 541/57 Taxman 152 and American Express International Banking Corpn. v. IAC [1983] 6 ITD 373; (h) Foreign Exchange fluctuation accounted for in books of account on any analised basis but not considered for tax purpose until the loss is incurred in profit actually earned (Indian Overseas Bank v. CIT [1990] 183 ITR 200 (Mad.)); (i) Interest earned in pre-commencement period is for accounting purposes reduced from the cost of assets in accordance with the Guidance Note issued by the Institute but for tax purposes assessed as income (CIT v. Cap Steels Ltd. [1986] 162 ITR 533/29 Taxman 125 (Kar.) at 536; CIT v. Derco Cooling Coils Ltd.[1992] 198 ITR 375 (AP)). 17. The aforesaid judgments clearly and conclusively prove that if an amount which has not accrued as income according to the provision of Income-tax Act but has been included as income in the books of account, it is the duty of the Assessing Officer to exclude such items of income. The Claim of differential income made by the assess....
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....[1986] 158 ITR 102. 2. The Assessee submits that as regards the first reason given by the Tribunal, it is submitted that the settled position in law, is that section 145(1) does not override the provision of section 5 (See the decisions of the Supreme Court in CIT v. A. Krishnaswamy Mudaliar [1964] 53 ITR 122, CIT v. State Bank of Travancore [1986] 158 ITR 102) and Kanga and Palkhivala Law and Practice of Income-tax page 1166. 3. As regards the reasons at (b) above, it is submitted that it has already been illustrated that there can be various circumstances under which the income computed in terms of the accounts presented for the Companies Act would not tally with the tax profits. It is further submitted that, method of accounting adopted by the assessee is not the index method of accounting as held by the Tribunal. The method of accounting adopted by the assessee is admittedly mercantile. It is only for recognising the revenue in its books of account that a particular accounting entry has been passed. 4. As regards (e) and (d) above, it is submitted that it is not even the case of the Revenue that the income reflected in the books of account has in fact been physically r....
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....irecting the Assessing Officer to allow depreciation on the basis of the circular of 1943. The assessee submits that the Circular lays down a method for recognition of the expenditure by way of finance charges in the hands of the hirer. When, as in the instant case, as per the assessee's agreement income also accrues in accordance with the method prescribed in the Circular there is no reason why a larger amount at all ought to be assessed. 8. As regards (g) above, the assessee submits that the crucial issue is that as far as lease rentals go what can accrue is only the monthly lease rental in accordance with clause 1.3 read with Schedule II of the agreement for lease. By no accounting entry can any sum in excess of the monthly lease rental accrue. Even IAS 17 does not contemplate a recognition of revenue in excess of what has accrued. 9. The decision in CIT v. Kameshwar Singh is distinguishable inasmuch as in that case the Privy Council upheld the assessability to tax of income which the assessee there had himself disclosed in the return of income. In the instant case, the assessee has not returned the income as assessed. The peculiar facts of that case have to be borne in mi....
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....e, is not a correct view. It is the duty of the Income-tax Officer, where there is such a method of accounting to consider whether income, profits and gains can properly be deduced therefrom and to proceed according to his judgment on this question. The decision in 6 ITR 36 has been approved and followed on this very point by the Supreme Court in CIT v. British Paints (I) Ltd.[1991] 188 ITR 44 at pp. 52 and 53. 11. The decisions mentioned at Serial Nos. (iii) and (iv) are completely distinguishable inasmuch as in those cases assessees who had adopted mercantile system of accounting in their books of account were seeking to be assessed in accordance with the cash method which the High Court as well as the Tribunal held was impermissible. The assessee submits that it has not adopting a different method of accounting for its books as well as for tax purposes. The method of accounting adopted is admittedly the mercantile method. It is only applying certain sophisticated accountancy principles in preparing its financial statements for recognising revenue. That a distinction between the profits and book profits in brought out by the decision of the Privy Council in CIT v. Sarangpur Co....
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....e relevant previous year or in other words, whether it comes within the ambit of charging Section 5 of Income-tax Act. In the present case, the entire amount of differential income did not accrue to the assessee as per the terms of the respective Hire Purchase/Lease Agreements. 21. The learned counsel also invited our attention towards the decision dated 13-6-1995 of Income-tax Appellate Tribunal "A" Bench, Allahabad in the case of Sahara Investment India Ltd. in [IT Appeal No. 254 (All) of 1995 dated 13-6-1995] and others. In that case, it was, inter alia claimed by the assessee that credit to the profit and loss account of administrative and process charges Rs. 3,17,529 being part of deposit received under the scheme had been erroneously credited to the profit and loss account and that the same be withdrawn since subscription received under the scheme was capital in nature and no part thereof was liable to tax. On behalf of the Department, it was inter alia, argued that nobody else could be a better judge than the businessman who in his prudence thought fit to return a part of the loan or deposit as income under the head Administrative and Process charges, and, therefore, the ....
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....n relating to invoking of the proviso to section 145(1) does not arise. He also placed reliance on judgment in the case of CIT v. McMillan & Co. [1958] 33 ITR 182 (SC) at page 183 in which it was held that the non-exercise of a power is also a decision inasmuch as it amounts to acceptance of the method of accounting followed by the assessee. 23.2 The learned Sr. D.R. further submitted that the expression used in the relevant provisions of Companies Act in relation to Profit and Loss account and Balance Sheet was "true and correct", which was subsequently substituted by the expression "true and fair". There is a subtle distinction between these two expressions and the concept of "true and fair" requires disclosure of real income in the profit and loss account and a true and fair view of the state of affairs as on the date of the Balance Sheet. He submitted that the meaning of term "accrual" under mercantile system of accounting is a same under the provisions of Companies Act as well as under the Income-tax Act. 23.3 The learned D.R. submitted that all the cases cited by the learned counsel for the assessee falls under the exceptions enumerated in the Accounting Standards, whic....
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.... or whether real income has materialised or not, various factors will have to be taken into account. That has really accrued to the assessee has to be found out and what has accrued must be considered from the point of view of real income taking the probability or improbability of realisation in a realistic manner. But once accrual takes place, on the conduct of the parties subsequent to the year of closing, an income which has accrued cannot be made 'no income'. These submissions were made on the strength of judgment of Hon'ble Bombay High Court in the case of Western India Oil Distributing Co. Ltd. v. CIT [1994] 206 ITR 359/73 Taxman 565. The learned Senior D.R. also placed reliance on judgment of Hon'ble Rajasthan High Court in the case of S.M.S. Investment Corpn. (P.) Ltd. v. CIT [1993] 203 ITR 1001 to support his contention that income had accrued to the assessee as soon as the assessee acquired the right to receive the income under the said agreement. The income covering the entire period of agreements has been apportioned according to SOD method in a rationale, systematic and appropriate method by the assessee in its books of account. 23.5 The learned Sr. D.R. further poi....
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....even injustice do not afford justification for exempting income from taxation, as opined in Mapa v. Oram [1969] 3 All ER 215 (HL), no injustice would really be caused in the cases at hand, inasmuch as if the advance in question can ultimately be established to have become a bad debt, the assessee would be entitled to refund of the tax already paid by him in this regard." 23.7 The learned Sr. D.R. also drew our attention towards the following para from the judgment of Hon'ble Supreme Court in the case of Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 at page 840: "The appellant-company admittedly was maintaining its account, according to the mercantile system. It is well-known that the mercantile system of accounting differs substantially from the cash system of book-keeping. Under the cash system, it is only actual cash receipts and actual cash payments that are recorded as credits and debits whereas under the mercantile system, credit entries are made in respect of accounts due immediately they become legally due and before they are actually received; similarly, the expenditure items for which legal liability has been incurred are immediately debited even before the amounts ....
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....ase rentals, as the entire amount of lease rental specified in the lease agreements has been shown as income liable to tax in the return of income. Amounts in excess of such agreed amount of lease rental accounted for in the books on the basis of SOD method represents hypothetical income, which did not in fact, accrue in the relevant previous year. The learned counsel once again urged that the Revenue's appeal being devoid of any merit, should be dismissed. 25. We have carefully considered the submissions made by the learned representatives of the parties and have perused the orders passed by the learned Departmental authorities. We have carefully considered the decision of the Division Bench of the Tribunal in the case of Nagarjuna Finance (P.) Ltd. We have also carefully gone through all the judgments relied upon by the learned representatives of both sides, the judgments referred to in the impugned order of the CIT(Appeals), as well all the decisions referred to in the order of the Tribunal in the case of Nagarjuna Finance (P.) Ltd. We have given our thoughtful consideration to all other documents, International Accounting Standards (IAS), and the Guidance Notes issued by the....
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....ned in section 5 and other relevant provisions in the light of principles of law laid down in the various judgments discussed hereinbefore, the following well-settled principles of law clearly emerge: (i) That the provisions of section 145 cannot override section 5 of the Act. If an income has neither accrued nor received within the meaning of section 5 of the Act, whatever section 145 may say, such income cannot be charged to tax even though a book-keeping entry has been made recognising such hypothetical income, which in law and on fact did not really accrue or arise or received in previous year. Section 145 determines the mode of computing the taxable income. It does not affect the range of taxable income or the ambit of taxation. The computation provisions cannot enlarge or restrict the content of taxable income. The range of taxable income or ambit of taxation is to be determined in accordance with the charging provisions. (ii) The proviso to section 145(1) does not merely confer a discretionary power upon the Assessing Officer but also imposes a statutory duty on the Assessing Officer to examine in every case whether income, profits and gains chargeable to tax in the re....
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....n be bifurcated into the following two categories of income : (i) Finance income in relation to Hire Purchase Agreements : Rs. 4,61,038 (ii) Income by way of Lease Rentals as per lease agreement : Rs. 48,22,893 ------------------------- Rs. 52,83,931 ------------------------- The aforesaid bifurcation of differential income is not borne out or verifiable from the orders passed by the Assessing Officer or the CIT(Appeals) and that will be a matter of verification by the Assessing Officer in the light of entries in the books of account and the terms and conditions of each and every Hire Purchase Agreement and Lease Agreement. The assessee has submitted copy of one of the H.P. Agreements and one of the Lease Agreements in the compilation and it was the contention of the learned representatives of both sides that all other Hire Purchase Agreements and Lease Agreements are almost identical and similarly worded. We will, therefore, consider the submissions made by the learned representatives of the parties with regard to the aforesaid two categories of differential income keeping in view these specimen and illustrative Hire Purchase Agreement and Lease Agreement submitt....
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.... of finance income in its books of account and on the basis of equated method for the purposes of income-tax returns is given below : The said working given by the assessee for disclosure of income from hire purchase at page 88 is reproduced hereunder : Amount financed 7,50,000 Finance charges (@) 14 per cent for 48 months) 4,20,000 ------------------- Gross Receivable 11,70,000 Period in months 48 Equated monthly instalment (EMI) (Gross Receivable/Period) 24,375 ------------------------------------------------------------------------------------ Formula Index Inst. Equated Method No. Method ------------------------------------------------------------------------------------- 420000 x (48/(48 x 49)/2)) 17142.86 48 420000/48 8750 420000 x (47/(48 x 49)/2)) 16785.74 47 420000/48 8750 420000 x (46/(48 x 49)/2)) 16428.75 46 420000/48 8750 420000 x (45/(48 x 49)/2)) 16071.43 45 420000/48 8750 420000 x (44/(48 x 49)/2)) 15714.29 44 420000/48 8750 420000 x (43/(48 x 49)/2)) 15357.14 43 420000/48 8750 420000 x (42/(48 x 49)/2)) 15000.00 42 420000/48 8750 420000 x (41/(48 x 49)/2)) 14642.86 41 420000/48 8750 420000 x (40/(48 ....
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....ion of each equated Monthly Instalment (hereinafter referred to as 'EMI') between principal component and finance charges/ interest component is more rational, appropriate and in consonance with law, so that the correct accrual of income by way of finance charges chargeable to tax of the relevant previous year may be determined. 31. The finance charges/interest calculated @ 14 per cent p.a. on Rs. 7,50,000 comes to Rs. 1,05,000 for one year. The total amount for 4 years has, thus, been computed at Rs. 4,20,000. The gross amount recoverable from the Hirer has been arrived at Rs. 11,70,000 (7,50,000 + 42,000) which will be repaid in 48 equated monthly instalments of Rs. 24,375 every month. In the model agreement, it is stated against Rs. 4,20,000 as finance charges and not interest. It is no doubt the argument of Departmental Representative that 'finance charges' are nothing but interest, but when we are applying the theory of appropriation, this distinction, if any, found existing between the finance charges and the interest, assumes significance. The further question would be whether any distinction is to be maintained between the payment of Rs. 4,20,000 and Rs. 7,50,000 while c....
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....lly known fact that interest is the price for use of money. In other words, it is a payment by way of compensation for use of funds provided by the Company to the Hirer. It is a uniform rate of interest charged not with reference to original amount of funds made available but in proportion to the outstanding balance from time to time. The principal amount which is paid does not have to suffer interest burden on the assessee simply because it was originally given at that figure. The real and effective rate of interest implicit in the contract of Hire Purchase will, therefore, have to be determined by apportioning the amount of each EMI of Rs. 24,375 in such a manner that the entire amount of interest income of Rs. 4,20,000 covering the period of 4 years of the contract is apportioned over the period of the contract in proportion to the reducing balances that will be outstanding from time to time. A perusal of chart given at page 35 indicates that out of first equated monthly instalment of Rs. 24,375, the assessee-company has appropriated in its books of account a sum of Rs. 17,142.86 towards interest and the balance amount has been appropriated towards repayment of principal. In the....
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....s inter alia considered similar arguments as were advanced before us in relation to recognition of finance/interest income arising under the H.P. Agreement on SOD method and has given elaborate and convincing reasons in the order while deciding this issue against the assessee. After giving our deep and thoughtful consideration to the entire relevant material, we find ourselves in agreement with the reasonings and the finding given by the Tribunal in the case of Nagarjuna Finance (P.) Ltd. in so far as the income under hire purchase agreements are concerned. Since we have expressed our agreement with the reasonings given in the aforesaid earlier order passed by the Tribunal in relation to income under the H.P. Agreements, we do not consider it necessary to repeat the elaborate reasons recorded in the said order of the Tribunal by which all the Submissions made on behalf of the assessee in this regard were repelled. 35. The reliance placed by the learned counsel on the Circular No. 9 dated 23-3-1943 and its reaffirmation vide Instruction No. 1057 dated 19-9-1977 would not in any manner help the assessee. The said circular mainly clarifies that depreciation on plant and machinery p....
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.... examine the facts relating to income by way of lease rentals as per lease agreements. 38. The assessee has submitted a copy of one of the lease agreements, as a specimen copy of such lease agreements executed with various clients, at pages 62 to 87 of the compilation. The Vijaya Kumar Mills Ltd., the lessee was desirous of acquiring the equipment described in Schedule I of the Lease Agreement and had, therefore, approached the assessee-company (the lessor) to purchase the said equipment and give it on lease to the lessee for a period of 96 months (8 years) on the terms and conditions set forth in the lease agreement executed between them on 27-7-1984. The cost of the equipment was Rs. 4,07,800. The lessee agreed to pay monthly lease rental @ Rs. 7,816.20 per month for a period of 96 months. Thus the gross lease rent payable by the lessee to the lessor over a period of 96 months come to Rs. 7,816.20 X 96 months Rs. 7,50,355.20. The fixed period of the lease of 96 months was a non-cancellable term of the said agreement. The lessors were entitled to recover the entire amount of the rentals for the fixed period in the event of termination of the agreement on a prior date. The lesso....
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....arge (interest) and the principal component. The impact of the principal on the credit side included in gross lease rent is neutralised by depreciation provision in the hands of the lessor. 41. We may also examine the various prudential norms for income recognition, accounting standards clarified in some of the Guidance Note issued by the Institute of Chartered Accountants of India as well as in the International Accounting Standards. 41.1 The International Accounting Standard 17(IAS 17) has recommended the accounting of lease transactions in the books of the lessors as under : "Accounting for Leases in the Financial Statements of Lessors. Finance Leases : An asset held under a finance lease should be recorded in the balance sheet not as property, plant and equipment but as a receivable, at an amount equal to the net investment in the lease. Subject to the consideration of prudence, the recognition of finance income should be based on a pattern reflecting at constant periodic rate of return on either the lessor's net Investment outstanding or the net cash investment outstanding in respect of the finance lease. The method used should be applied consistently to lease o....
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....those due but not received) under a finance lease should be shown separately under 'Gross Income' in the profit and loss account of the relevant period. 11. It is appropriate that against the lease rentals, a matching lease annual charge is made to the profit and loss account. This annual lease charge should represent recovery of the net investment/fair value of the leased asset over the lease term. The said charge should be calculated by deducting the finance income for the period (as per para 12 below) from the lease rental for that period. This annual lease charge would comprise (i) minimum statutory depreciation (e.g. as per the Companies Act, 1956) and (ii) lease equalisation charge, where the annual lease charge is more than the minimum statutory depreciation. However, where annual lease charge is less than minimum statutory depreciation, a lease equalisation credit would arise. In this regard the following accounting entries/disclosures should be made : (a) A separate Lease Equalisation Account should be opened with a corresponding debit or credit to Lease Adjustment Account, as the case may be. (b) Lease Equalisation Account should be transferred every year to t....
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....omprising the lease term. 13. Net investment in the lease may often be equal to the capital cost/fair value of the asset at the inception of the lease. However, as per the definition, net investment is the difference between the gross investment in the lease (i.e., the aggregate of the minimum lease payments from the standpoint of the lessor and any residual value accruing to the lessor) and the unearned finance income (i.e., the difference between the lessor's gross investment in the lease and its present value). 14. Initial direct costs, such as commissions and legal fees, often incurred by lessors in negotiating and arranging the lease should normally be expressed in the year in which they are incurred. Similarly, income on account of lease, e.g. management fees, should be recognised in the year in which they accrue." Operating Leases : A lease is classified as an operating lease if it does not secure for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term. Therefore the asset and rentals receivable should be included in income over the lease term. Costs, including depreciation, incurred in earning the rental inc....
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....rge and the principal component, but has credited the entire amount as income of revenue nature. The assessee has not periodically transferred any amount in lease Equalisation Account with a corresponding debit or credit to lease adjustment account, as indicated in the Guidance Note. In fact, the IAS- 17 shows that where plant and equipment is shown as an asset and depreciation is claimed by the lessor, the rental income should be recognised on a straight line basis over the lease term and depreciation of leased assets should be claimed on a basis consistent with the lessor's normal depreciation policy. 42.1 In the aforesaid example, the assessee has a right to receive annual lease rent of Rs. 30 per annum as per the lease agreement. The income which accrues to the assessee as per the Agreement is only Rs. 30 per annum. Any amount of income accounted for in the books of account in the first few years of the lease term beyond the amount of Rs. 30 clearly represents hypothetical income which did not in fact accrue to the assessee in the relevant accounting year. 43. The assessee in its income-tax returns has declared income by way of lease rentals on the basis of lease rent fix....